Six MLPs To Own As Interest Rates Rise

By Dimitra DeFotis

The companies that made the short list are mostly in pipeline and related infrastructure business: Magellan Midstream Partners (MMP), Plains All American Pipeline (PAA) and Sunoco Logistics Parters (SXL) boast the best overall traits, but Access Midstream Partners (ACMP), Enterprise Products Partners (EPD) and Williams Partners (WPZ) also made the grade.

MLPs pay out most of their cash flow as tax-deferred distributions. Yields on the Ned Davis Bond Bear Survival list range from 3.7% (Magellan) to 6.5% (Williams Partners.)

In recent years, low rates helped finance the construction of new U.S. oil-and-gas pipelines and processing facilities. Most MLPs funded this construction with a combination of debt and issuance of new units, as shares of MLPs are called. After debt markets froze during the financial crisis, MLPs have attempted to whittle debt and issue an equal amount of equity.

Ned Davis authors Warren Pies, a commodity analyst and member of the most recent Barron’s MLP roundtable, and John LaForge, a Ned Davis commodity strategist, write:

“While new-found sources of oil and natural gas will create lucrative opportunities for MLPs, the prospect of persistently rising interest rates is an opposing force that bullish investors must reckon with. In the past 18 years, since the inception of the Alerian MLP Index, 10-Year Treasury Note Yields have fallen from above 7% to below 1.5% (~2.5% today). However, we are hard-pressed to envision yields falling from here. Joe Kalish, NDR’s Chief Global Macro Strategist … is not officially declaring the start of a secular bond bear [market, but] he is expecting rates on the 10-Year to creep higher in the coming years – some 300+ basis points from the 2012 low. This kind of rate levitation is unprecedented during the modern MLP era. Everything else being equal, a dramatic move higher in rates will compress MLP yield spreads (i.e., risk premiums) and lower returns … as yield spreads narrow, investors are pricing in higher distribution growth in the next 12 months. Another way of interpreting this is that lower spreads indicate higher expectations and a lower margin of safety for investors.”

For more on how rising interest rates impact MLP funds, see what Kayne Anderson portfolio manager and MLP industry veteran Kevin McCarthysaid earlier this year.